It was just two short years ago that a profound wake-up call hit
the capital markets. The numbers game of raising money had been
reluctantly redefined during the 60 months that spanned from the
first quarter of 1994 to the peak of the Nasdaq in first quarter of
2000. Fundamental valuations had given way to customer-driven
metrics such as industry share, volume and first-to-market
presence. Many on Wall Street hailed the arrival of the new
"new math." Peter Henig, writing in Red Herring, said,
"As long as there's dynamic growth, there are dynamic
stock prices." And the recommendation that came down from
Charles Crane of investment research firm Key Asset Management was,
"If you believe in these new statistics, then you have to buy
these stocks."

But today, huge opportunity and market share are no longer
enough to secure a funding deal for your growing firm. Raising
money has taken a turn back to the basics. And as company earnings
have come back in line with the mainstream, the real numbers game
for your deal is now focused on the most elementary component in
your enterprise: your business model.

"Our initial test of any investment has to do with the
validity and strength of the business model and how the management
team's core experience can be used in the execution of that
model," says Jeff Carmody, a bridge loan specialist with Santa
Barbara, California-based Agility Capital.

"The period in time where money was raised from a flow
chart drawn on a cocktail napkin has, mercifully, passed,"
notes Jason Spievak, vice president of business development for
Callwave, a Santa Barbara, California, next-generation
software-based switching technology firm. "To be taken
seriously by investors today, an entrepreneur needs to have both
the long-term strategic vision as well as the practical focus on
operations. A real business model that can drive sustainable
revenues is a must because while there's more capital than ever
piled up in private equity funds, very little of it is available to
the dreamer or the get-rich-quick entrepreneur."

Details, Details

Your business model describes how your business goes from
preparing your product or service to delivering it to your users,
and how many of those transactions you need to execute to keep up
with your operating costs.

You must include these details when creating or reformulating
your business model:

1. Suppliers and the average price of your company's
goods

2. Labor costs per each unit your company produces

3. Selling price and the resulting gross profit margin

4. The amount your business needs to ship weekly to break
even

5. Your company's annual output and the break-even point as
a percentage of total capacity

A strong business model identifies who is buying your product or
service and why they choose to do business with you as opposed to
your competitors. It then offers a clear rationale for why buyers
will pay the price you're charging (say, $50 per unit).

Once you give solid reasons for the buying decision, you need to
report how many sales per day you make. If you say daily sales
activity averages 250 customers (5,000 each month), then the
revenue component of your model at $50 per unit is $12,500 each
day. This metric has to make sense with respect to the scale and
scope of your operation.

Next, you clarify your labor and materials costs in relation to
your expenses. Perhaps your labor and materials costs for each sale
are $28, leaving you with $22 per sale in gross profit, a 44
percent margin. If your overhead is $85,000 a month, that $22
profit margin needs to happen about 3,860 times every 30 days to
break even with your fixed monthly costs. So the model now rests on
whether you have the capability to do that kind of volume. If so,
you have a sustainable business model where the first 3,860
customers each month cover all your costs, and the next 1,140
contribute $22 each ($25,000) to your pretax profit.

Take a look at this example of a poorly-thought-out business
model: You have a "cool idea" that costs $60 in labor and
materials to manufacture, and overhead runs $100,000 per month. You
might believe a price of $75 will draw potential buyers, but with a
$15 profit margin, you'll need to sell nearly 6,700 units every
30 days--and right now you're doing business at an average rate
of less than 125 customers per day. These metrics don't
work.

Or maybe you project a price of $100 (a 40 percent margin),
which would drop your monthly volume point to 2,500 units. The
problem is, there's no way to sustain that price-point given
the competitive environment. In both these cases, the numbers
don't add up, and the business model is not sustainable. There
are many cases where entrepreneurs have come up with poor business
models where the volume needed to cover monthly fixed costs would
have to be 75 percent of the overall market share. Again, that
scenario is unreasonable, and investors won't support it.

Where the Money Is

Banks and investors are anxious to provide financial backing for
your company's growth. Yet they have to make the connection
between the opportunity you're focused on and the details of
how your model converts that opportunity into regular monthly cash
flow. "When we sit down with company owners to talk about
funding growth, I want to see a defined repayment source with an
eventual exit strategy," says Ken Jacobsen of the Arroyo
Grande, California-based corporate lending division of MidState
Bank & Trust. "Your management team's experience
combined with an identifiable comparative advantage offer a solid
foundation upon which to make your funding pitch. But having a
great business model solidifies the next crucial step of mapping
out how revenues happen, where profits come into the picture, and
at what level of customer-adoption the enterprise becomes
profitable."

So the next time you outline a great idea for increasing your
market base, take on a key strategic alliance, or augment your
product-service line to broaden your customer appeal, be sure to
formulate the crucial metrics that make your scheme workable. When
you finally land a meeting with a potential funding source, that
business model will ultimately demonstrate your credibility and
expertise, and you'll significantly improve your chances of
securing the funds your firm needs.

David Newton is a professor of entrepreneurial finance at
Westmont College in Santa Barbara, California, and has consulted
for more than 100 companies since 1982.